How to Value a Practice

On September 9, 2013, in practice valuation, by Dan

I consult on several practice sales a year. Sometimes it’s for buyers, sometimes for sellers, or sometimes it’s mediating for both, but the biggest challenge in every case is always the same: deciding what the practice is worth.

The problem is not that the math is hard. The problem is that there’s no right answer. The right number, in the end, is really the one that everyone can agree on. The trick isn’t the number, it’s getting agreement, and, more often than not, helping people see the value in buying a practice.

If you’ve found a practice for sale, or you’re selling yours, this post is designed to get you started in deciding what a practice is worth.

What Really Matters in Practice Valuation
It’s usually not that hard to figure out what the tangible assets of a practice are worth. Real estate, furniture, inventory–they’re usually not the sticking point. The difficulty comes in trying to decide what the intangible assets are worth. How much are your client files worth? What’s the value of a patient who came to see you six month ago? Six years ago? Six days ago? How much is your “brand” worth? Your logo? Your referral network? Your awesome admin assistant?

The answers to those questions, it turns out, tend to be in the eye of the beholder. Buyers and sellers naturally have a different idea about what things are worth.

What matters most is to put energy where it belongs. There’s an important principle to work from here: It’s almost always more important to get the deal done then to get the price exactly right. 

The greatest risk in buying or selling a practice is not that you’ll pay too much, or sell for too little, but that you won’t buy or sell at all. 

I believe you’re far better off to overpay a little for a good practice then to build from scratch. And you’re better off selling for half price than just walking away.

Does this mean you shouldn’t take valuing your practice seriously? Not at all. It just means that when you’re second-guessing yourself every step of the way (which is normal) keep in mind that there’s no right number.

How to Value Your Practice

Having said that, I’m going to suggest four ways to approach valuing your practice. These are fairly broad strokes, but they’ll get you started. Besides, saying things like, “present value of a practice’s future earnings stream discounted at an appropriate risk-adjusted rate of return,” just makes everyone unhappy so we’re going to keep things simple. :)

The more ways you can value a practice, the better. After all, if you’re selling, you need plenty of evidence to support your valuation, and if you’re buying, you need plenty of evidence to justify spending the money. So you may want to give all these a try.

METHOD 1: Use an Established Professional Standard
Some associations have recommendations for valuing patient/client files. Often this is based on giving files a value based on age or activity. You might, for example, have different values for active, semi-active, and inactive files. You can find examples of that for massage therapists here, and for naturopaths here.

Pros:

  • It’s simple. It’s pretty easy to add up files and multiply by some standard amount. Then you can add in real estate and other assets, and you’ve got a ballpark number.
  • It creates common ground. What I like best about this method is that it gives some sort of starting point. If your association is recommending it, then at least a seller can say, “I valued my files using this professional standard.”

Cons:

  • Inaccuracy. Per-patient valuation, and recommend rules of thumb tools (below) tend to ignore differences between practices. What if your clients are worth twice the average because you operate differently, or have better retention and return rates? What if your “brand” is worth more? These are all part of your practice’s “goodwill” and vary from practice to practice.

How to Do It:

  • Contact your state/provincial/regional association.
  • Contact your national association.
  • Contact your regulatory college or governing body.
  • For each, ask about standards, and ask for recommendations of other practitioners and professionals to contact who might have some insight.

METHOD 2: Ask Your Peers
Many of the integrative and alternative professions don’t have established standards, and it can be hard to find information on what other practices have sold for. Often, your best resource is to simply start asking around.

Pros:

  • Relevant info. Talking to other acupuncturists about practice sales is going to give you more relevant info than talking to a valuation expert who’s never looked at an acupuncture practice
  • Contacts and support. Finding people in your industry who have done this before can really ease your mind, particularly if you’re buying. They’ll also likely point out all kinds of little details and pitfalls you haven’t thought of.

Cons:

  • Small sample size. If you talk to three people who’ve bought or sold, the odds of their practices being like yours are low.

How to Do It:

  • Email your practitioner peers asking for advice.
  • Put the word out in discussion groups, forums, social media, etc. (if you don’t mind going public)
  • Remember: it’s probably not your friends who know, but someone they know who can help. It’s a networking job. You should be able to come up with several people just by putting out a few feelers.

METHOD 3: Use a Valuation Rule of Thumb
There are plenty of “rules of thumb” used to value businesses. They’re simple financial estimates to ballpark the value of a business.

Here are a few examples of rules of thumb:

  • One year’s gross revenue
  • Average of last 4 years gross revenue
  • 70% of last year’s gross income
  • 2 times one year’s net income

These are generally ways of valuing the “intangibles” of the business, and don’t include significant assets like real estate or equipment.

Pros:

  • Simple: If you have a rough idea of what a “rule” should be for a practice, it’s really easy to quickly assess a rough value.

Cons

  • Too Simple. These really are rules of thumb. They’re for quick-and-dirty estimating, and should be used accordingly. I like the rules of thumb based on net income or profit better, because expenses can vary so much between practices. A practice that bills $150K with $20K in expenses is a lot different than one that bills the same $150K with $80K in expenses.
  • Which rule to use? For many professions, there simply aren’t enough practice sales tracked to really know what the multipliers should be. There’s lots of data for dentists, for example, and some for chiropractors, but what about reiki or rolfing?

How to Do It:

  • Use Method 1 & 2 above, but ask about business valuation standards while you’re at it. The math is easy–it’s just deciding on a “multiplier” that’s hard.
  • Ask your accountant or lawyer for a quick-and-dirty guess.
  • My rough rule of thumb? If you can pay one year’s net income or less for a practice, then you’re on to something. That means a brand new practitioner could buy a busy practice and go from zero to a great income in two years. Most people don’t do that building from scratch.

METHOD 4: Hire an Expert
There are people out there who specialize in this stuff, and they’re good at it. If you want to move past the guessing and ball-parking of the other methods, this is your next step.

Pros:

  • Accuracy. When you use this method, you’re generally using real data,  worked up by someone who has some advanced business analysis mojo.
  • Credibility. Having a practice valued by a pro can lend some cred to the sticker price.

Cons:

  • Cost. It takes time and money to hire a pro. They’re going to want to do a real valuation, not just make a ballpark guess. But if you want professional advice based on real numbers, you should consider it.
  • Relevance. It’s hard to find a specialist who understands some of the less common health care professions. They’ll give you a value, but you’ll still need to explain that to a new practitioner who likely has very little appreciation for why buying a practice is so important.

How To Do It:

  • Ask your accountant or lawyer. Often they’ll know someone who does this stuff.
  • Ask a few business owners. Someone will know someone.
  • Search online. There are a few specialists for some professions, like chiropractic.

Whatever method you use, remember to do your homework, and don’t forget that buying and selling practices is good for practitioners, patients, and professions!

 

Join the Journey!

Related posts:

  1. The 3 Critical Questions You Need to Ask to Buy The Right Practice
  2. The Case for Buying A Practice
  3. How to Find a Practice For Sale
  4. Tips for Starting Your First Dispensary
 

1 Response » to “How to Value a Practice”

  1. Thank you for this great summary about practice valuation. Could you follow it up with a discussion about how to best market your for-sale practice? Craig’s list, professional associations, discussion lists, trade journals, practice brokers, etc? Also how do you time the process?

    Thanks!

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